Most people know that to qualify for a loan they need a good credit history and reasonable ‘credit score’. They also know that their credit score is something provided by the major credit bureaus. In Canada that means TransUnion and Equifax. What most people may not know is that those scores have become big business, and in many instances, are meaningless.
Recently the Consumer Financial Protection Bureau (CFPB) in the United States ordered both these credit bureaus to refund consumers (and pay a fine) for falsely advertising free credit scores. Their tactics of auto-enrolling consumers for subscription plans to monitor their credit score was also targeted as unfair. This was big news across much of the main stream and social media.
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From FICO to proprietary credit scores
The big part of this story is the fact that the credit scores offered by the credit bureaus were not necessarily the same ones seen by your lender when you apply for a loan. In the U.S., FICO first developed a credit scoring system in 1981 to measure the risk that someone will default on a loan. FICO made money by selling the score to the credit bureaus who, in turn, sold them to lenders. In effect, all the credit bureaus did was collect, aggregate and sell information. They got credit scores from FICO, and information about your credit behaviour (late payments, loans outstanding etc.) from lenders.
It didn’t take long for the big credit reporting agencies to realize they could use the information they collect to build their own proprietary credit scores and stop paying FICO. However, in the U.S. most lending institutions still use the FICO score when assessing your loan application.
Hence the CFPB’s findings that if credit bureaus sell you their own score, they are not selling you the score typically used by lenders to make credit decisions.
It’s kind of the same in Canada
In Canada, lenders don’t just use FICO. Instead they request your credit score from either Equifax or TransUnion, whoever they are dealing with. The problem is you won’t necessarily know which credit report (and credit score) your lender is using. So if you pay TransUnion to monitor your credit score, while it might help you identify some red flags, it won’t necessarily tell you what your Equifax score is.
And things get even dicier. Even in Canada, lenders don’t rely just on your credit score. TransUnion and Equifax have developed multiple scoring systems that they sell to lenders – not all of which you can see. One such score is known as your bankruptcy score. This can result in someone with ‘good credit’ being turned down for a loan because this additional score tells a potential lender that you are a high bankruptcy risk even though you have a high credit score.
Credit scores are big business
The thing is, credit scores aren’t just used for assessing loan applications anymore. Today they are a very big business in and of themselves with many, many people making money from credit scores in one way or another.
- Credit bureaus make money selling your score to lenders.
- Credit bureaus make big money selling you a subscription to monitor your credit score. Even if you have good credit, they sell their service as an important fraud protection.
- Credit bureaus make money selling your credit score to sub-prime lenders, who offer to grant you access to your score for free if you sign up for their product. The problem is, most of these lenders offer high-cost loans very similar to payday loans or high interest term loans and the free credit score isn’t really worth it. These same companies make money by lending you more money.
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When to worry about your credit score
If you have all the credit you need, you don’t need to pay to monitor your credit score. Credit bureaus are required to provide you with a free copy of your credit report once a year. This is all you need to review for potential fraud activity. Since there are two credit bureaus in Canada, stagger your requests so you can monitor your activity every six months.
If you are looking to apply for a loan, there are steps you can take to manage your credit report. Do this rather than sign up for monthly credit score monitoring. You should know if you have a history of late payments, or are over-extended on your credit cards. You don’t need a score to tell you. Once you’ve taken steps to improve your credit history, then and only then should you be applying for more credit.
My advice is don’t chase your credit score. Work on creating a balanced, healthy debt profile and your ability to get good credit will take care of itself. That means that if you have a lot of debt, you may want to talk to us about whether a bankruptcy or a consumer proposals is a good way to wipe the slate clean and start over.